Tuesday, September 19, 2017

Roger Farmer vs. George A. Akerlof and Robert J. Shiller on Monetary and Fiscal Expansion in 2009

Roger Farmer is among the most idiosyncratic, innovative, and provocative economists of his generation, a first class mathematical economist who’s willing to explain his theories and models in words, and to engage with heterodox economists on a variety of theoretical and practical issues.  In his most recent endeavor, Farmer aims to make "the case for unity between Post-Keynesian and General Equilibrium Theory under the banner of Post-Keynesian Dynamic Stochastic General Equilibrium Theory" (2017, p. 1).
I'm working on a paper challenging Farmer’s claim that he’s created an authentically Post Keynesian DSGE model or something superior to it.  In the course of my research, I came across a book review Farmer wrote in September 2009 (2009a) about Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism, by George A. Akerlof and Robert J. Shiller (Princeton University Press, 2009).  It turns out that this review is quite revealing, at least to my mind.  
To begin with, Farmer contends that Akerlof and Shiller’s “definition of animal spirits is far too broad,” “too broad” because it would require “jettisoning” neo-classical economics “almost all at once” even though "there’s still much to like about it," and “too broad” because there’s an ongoing and productive research program in which “animal spirits” are defined as “the self-fulfilling beliefs of market participants” (2009a, p. 357).  (Note: Farmer wrote a book entitled Macroeconomics of Self-Fulfilling Prophecies (1993, 1st ed.).
Farmer worries that, “by attacking classical theory on so many fronts at the same time, Akerlof and Shiller have torn down the house and left us without a shelter from the storm” (ibid., p. 358).  Although Farmer agrees that “the message of the book is that Keynes was right and that aggregate demand must be managed to restore full employment,” he also believes that “Keynesian economics was discredited in the 1970s and there are compelling grounds to be skeptical that fiscal and monetary policy will work today in the way that Akerlof and Shiller believe” (ibid.).
And then, in a statement that sounds very much like what Robert Lucas and Thomas Sargent wrote in their 1979 polemic, “After Keynesian Macroeconomics,” Farmer writes,
“Akerlof and Shiller’s book criticizes classical economics but does not offer a viable or coherent alternative.  Instead they advocate Keynesian policies that were discredited in the 1970s, a massive expansion of liquidity, and a massive fiscal expansion. History has taught us that a massive expansion of liquidity will lead to inflation. Logic tells us that a massive fiscal expansion will lead to a big transfer of resources to the baby-boomers from their grandchildren. The lesson of 1970s stagflation is that neither of these two policies alone can be guaranteed to restore full employment” (ibid., my stress).”
Let me draw your attention to the sentence I italicized, viz.,  History has taught us that a massive expansion of liquidity will lead to inflation.”  The chart below displays “Total Assets of the Federal Reserve,” which is sometimes used as a measure of liquidity.
                    Total Assets of the Federal Reserve (source: Federal Reserve)

       Every economist makes mistakes, but this one is rather stark given the confidence with which Farmer made his predictions.  Farmer is writing in 2009, during a period when the Fed was in the process of doubling its assets.  This process continued until 2015, as Fed’s balance sheet reached about $4.3 trillion.  Yet there was no acceleration of inflation.  Quite the contrary, the rate of inflation actually decreased during this “massive expansion of liquidity” to use Farmer’s own words.  Apparently, the economic history of the 1970s, properly understood, does not teach us that “a massive expansion of liquidity will lead to inflation.”
       The other Keynesian policy “discredited in the 1970s” was “a massive fiscal expansion,” like the one that’s “been applied already by the Obama administration” (ibid., p. 358).  So, to recap, we have Akerlof and Shiller arguing for more “fiscal and monetary stimulus” in 2009, and Roger Farmer warning that these policies, “like the Keynesian policies that were discredited in the 1970s,” are unlikely to the produce the effects Akerlof and Shiller are hoping for.  
       Let's take a moment to assess.  During this post-2009 period, the U.S. government’s fiscal stimulus (deficit/GDP for simplicity) decreased from almost 10% in 2009 to about 2.5% in 2015.  Akerlof, Shiller, Krugman, DeLong, Summers, and many other Keynesian and Quasi-Keynesian economists argued for more debt-financed investment spending during this time.  Would a fiscal expansion in 2010 or shortly thereafter have been a good thing for the economy?  Let me just say that pointing to Lucas and Sargent's claims about the supposed Keynesian policy and intellectual "failures" of the 1970s isn't sufficient to discredit the notion that additional fiscal stimulus following the Financial Crisis would have been good for the economy, especially in light of what has turned out to be false predictions of rising inflation.
When we look at the issue of fiscal expansion alongside Farmer’s confident, but, it turns out, false claim that “a massive expansion of liquidity will lead to inflation,” then we may begin to wonder whether Farmer’s mathematical constructions are really affording him a better view of the world.  I think it’s fair to say that Akerlof and Shiller’s predictions, real and implied, were closer to the truth than Farmer’s predictions, real and implied.  Perhaps Farmer’s next theory – A Post Keynesian DSGE Theory – will cast a brighter light on its subject.  This new theory will the subject of a forthcoming post.

Tuesday, July 4, 2017

UW Evans School Study of Seattle's Minimum Wage Looks Like an Outlier

Two new studies of Seattle’s minimum wage have recently been published. One was done by a UW Evans School team and finds that, over the study period, wages went up an average of 3%, while total labor hours decreased by 9%.  This amounts to an elasticity of -3.o, which simply means that a 1% increase in wages results in a 3% decrease in employment hours.

By contrast, a UC Berkeley study finds that raising "minimum wages in Seattle up to $13 per hour raised wages for low-paid workers without causing disemployment. Each ten percent minimum wage increase in Seattle raised pay by nearly one percent in food services overall and by 2.3 percent in limited-service restaurants. The pay increase in full-serve restaurants was much smaller and not statistically significant, consistent in part with higher pay in full-service restaurants and the establishment of a tip credit policy. Employment effects in food services, in restaurants, in limited-service restaurants and in full-service restaurants were not statistically distinguishable from zero. These results are all consistentwith previous studies that credibly examine the causal effects of minimum wages.

In addition to these local studies, there's a new meta-study focusing on 46 events with the largest wage changes, which found that average wages of the affected earners increased significantly by 10.8%, but that employment was little changed with a statistically insignificant increase of 0.2%. This study estimates 0.02 as the implied elasticity of employment with respect to wages, with 0.307 as its standard error, which rules out elasticities smaller than -0.585 at 95 percent confidence level. Not to put too fine a point on it, and ignoring the positive sign of employment, the meta-study's estimated elasticity of 0.02 is 1/15 the size of the UW study's elasticity of 3! Something seems to have gone haywire.

Commenting on the UW study, the authors of the meta-study contend that the idea that raising the minimum wage has a much larger effect on hours than on wages strains credulity, especially since, as economists Ben Zipperer and John Schmitt have noted, Seattle’s increase “is within the range of increases that other research has found to have had little to no effect on employment.” It’s not entirely clear why the University of Washington team gets such a weird result — since their data isn’t public, we can’t check it — but it’s worth noting at least two important issues with their study.

First, the UW data exclude workers at businesses that have more than one location; in other words, while workers at a standalone mom-and-pop restaurant show up in their results, workers at Starbucks and McDonald’s don’t. Almost 40 percent of workers in Washington state work at multi-location businesses, and since Seattle’s minimum wage increase has been larger at large businesses than at small ones — right now, a worker at a company with more than 500 employees is guaranteed $13.50 an hour, while a worker at a company with fewer than 500 employees is guaranteed only $11 an hour — these workers’ exclusion from the study’s results is an especially germane problem (note that low-wage workers in Seattle have had an incentive to switch from small firms to large firms since the minimum wage started rising). In earlier work, in fact, the University of Washington team’s results were different depending on whether these workers were included in their analysis; including them made the effects of the minimum wage look more positive.
Second, the University of Washington team does not present enough data for us to assess the validity of its “synthetic control” in Washington — that is, the set of areas to which they compare the results they observe in Seattle. The Seattle labor market is not necessarily comparable to other labor markets in the state, and given some of the researchers’ implausible results, it’s hard to believe the comparison group they chose is an appropriate one.

Discussion.  Let’s consider some examples of how firms and employees might respond to increases in the legal minimum wage.

1. The Perfect Competition case. Suppose workers supply services worth  $13/hour.  If a new Miniumum Wage were to exceed $13/hour, these workers would be offered fewer hours of work. This reduced demand for labor at higher wages is, in effect, the classical mechanism (the price effect) that's at work behind the scenes in the UW study, which found that a 3% average wage increase went hand-in-hand with a 9% reduction in total labor hours.

Yet, even if these UW percentages were correct, the classical interpretation of the results doesn’t necessarily follow.  It could be that, for some low-wage employees, the greater income afforded by the 3% wage increase (the income effect) allowed these employees to take classes, travel, etc., which shows up as a reduction in total work hours.

Now, there’s nothing in this "trade-off" between higher wages and few hours worked that justifies a claim made about the UW study, which is that the “cost” of a 9% reduction in paid hours “isn’t worth the “benefit” of a 3% increase in pay per hour of work.

It is true, however, that, all else equal, a reduction in total labor income, due to fewer labor hours (for whatever reasons), will have some secondary multiplier effects, in particular less aggregate demand, less sales revenue, and lower demand for labor.

2.  The Monopsony Case.  Suppose there’s a group of workers who produce $13.50/hour in value, but are only paid $10/hour.  Let's assume the employer knows she's getting this extra $3.50/hour in "exploitation profits." Let's also assume the employee knows this, but isn't interested in looking for another job.

·   In this case, raising the minimum wage to $13/hour shifts $3/hour from employer to worker. It’s still rational for the owner to keep the employee on payroll. If we assume the worker decides to remain at the now $13/hour job, then, all else the same, wages paid go up, while profits fall a bit (but not into negative territory).

·   Insofar as low-wage workers spend a larger proportion of their marginal income than business owners typically do, the shift of $3/hour from profits to wages will increase aggregate demand and sales revenue, pushing up demand for labor.

·   This effect could be important if large low-wage employers have bargaining advantages over individual workers.

3. The wage bargain as an implicit contract. Some labor economists believe that, at higher wages, workers work harder and smarter, and that there’s less labor turnover, which affords benefits to workers and firms. Depending on the size of minimum wage increase and the other factors involved, it's conceivable that more workers could be hired at higher wages. If so, wage income rises, profits may rise, sales revenue will increase, and the demand for labor will increase.

Monday, June 5, 2017

A Belated Reply to Janet Yellen's 1980 Critique of Post-Keynesian Economics

Brad Delong is in the excellent habit of reposting some of his older pieces, including a ten-year old post entitled “Keynesian Economicses and the Economicses of Keynes.”  Although Brad doesn’t mention it in his 2007 post, Janet Yellen wrote a harsh critique of Post-Keynesian economics in 1980, which was entitled “"On Keynesian Economics and the Economics of the Post-Keynesians".  I read Yellen’s 1980 paper recently and decided to write a reply. Here’s the abstract:

"Thirty years before Janet Yellen became Chair of the U.S. Federal Reserve, she wrote a blistering polemic entitled 'On Keynesian Economics and the Economics of the Post-Keynesians' (1980).  Ms Yellen criticized the Post-Keynesian theory of output and income distribution, vigorously defended the neoclassical synthesis, and extolled the virtues of the 'standard Keynesian IS-LM model.'  In this belated reply, I respond to Yellen’s criticisms of Post-Keynesian economics, expose some flaws in her own distinctive version of the IS-LM model, and outline a few implications of Ms Yellen’s ironic epiphany, 'A Minsky Meltdown: Lessons for Central Bankers” (2009)' for contemporary debates in macroeconomics."

Thursday, June 2, 2016

Seattle Pension Fund to Shield its Private Equity Partners from Public Disclosure

Last year, the Seattle Pension System tripled its investment in Private Equity, an asset class known for its tax loopholes, controversial business practices, and lack of transparency. This year Seattle lobbied the State Legislature seeking to shield its Private Equity managers from public scrutiny.

And in a few weeks, the City will get its wish. After June 27, 2016, the public pension systems of Seattle, Tacoma, and Spokane will have the authority to reject public disclosure requests concerning the fees and expenses they pay their Private Equity partners (here).

Now, bearing in mind that Seattle was the first big city to adopt a $15/hour minimum wage, doesn't it seem a bit odd that this Citadel of Liberalism and Democratic Socialism would so tightly embrace an investment class that's been described as a vehicle for transferring wealth to the 0.1%?

Why did the City of Seattle capitulate? According to the Retirement Board's April 14, 2016 minutes, the new public disclosure exemption will give Seattle's pension system "greater access to top private fund managers." Why? Because "some [Private Equity] managers have told staff they were not interested unless they were an exception [to public disclosure requirements]."

Shielding Private Equity managers from public scrutiny is not a trivial matter, and I should like to ask Seattle's Mayor and City Council, "How much more expected revenue is required to gain the City's cooperation in concealing Private Equity fees from the public?"

The Private Equity industry claims it needs secrecy to protect its sophisticated analytical techniques from competitors. But a more plausible explanation can be found in a recent study by the Securities and Exchange Commission (SEC), which revealed that more than 50% of a large sample of Private Equity firms were overcharging investors (see here). According to a recent study by Oxford professor, Ludovic Phalippou, "Private equity firms have charged hidden fees amounting to $20 billion to companies" (see here, here, and here).

The SEC findings are actually small potatoes compared with Seattle's own Private Equity misadventures. A few years ago, the City went to court simply to get information on its $20 million investment in Epsilon II, with offices in the Cayman Islands, and a Ponzi scheme stretching all the way to Minnesota (see here). The judge rejected the City's plea, mocking Seattle for demanding transparency after the City's Pension Fund had placed a $20 million bet on "a foreign investment that by its own terms provided for only minimal transparency."

"But this is just one case," it will be objected. The chart below displays Seattle's Private Equity returns compared with Vanguard's low cost Small Cap Growth Index Fund for periods ending on 12/31/2015.

Granted, even the 7-year period in the graph is too short to rule out "bad luck" as the primary cause of Seattle's poor performance. On the other hand, the average annualized returns of Seattle's Private Equity portfolio would be significantly lower than the returns shown in the chart if the SEC and Oxford findings apply to Seattle. If Seattle is confident that its Retirement System isn’t paying any bogus fees to its Private Equity partners, then why not disclose these fees to the public?

Recall to mind the Financial Crisis, Mitt Romney and Bain Capital, Occupy Seattle, the 1% and the 99%. Thinking globally, the City of Seattle publicly condemned “unjust tax systems” and expressed grave concern about “growing income disparity” in Resolution 31337. But acting locally, Seattle officials doubled down on the City's investment in an industry that thrives on “unjust” tax loopholes and is front-and-center in the march toward greater inequalities of wealth and income.

Not to put too fine a point on it, but Seattle's commitment to Private Equity – with both the City's dollars and its readiness to shield its Private Equity partners from public disclosure – is an affirmation of the very same economic arrangements Seattle's elected officials criticized so sharply after the Occupy Seattle protests – special tax loopholes for the 0.1%, increased inequalities of wealth and income, and the distorting influence of big money in politics.

Wednesday, March 2, 2016

Unravelling Some Occult Mysteries of the Heterodox

Noah Smith has a new post, "Occult Mysteries of the Heterodox," criticizing Heterodox economists who seem unable to provide a simple explanation of their new, and supposedly superior, methodologies. “They show every indication of having no new methodology whatsoever.”  And later, in a "tweetstorm," Noah accuses Post Keynesians, in particular, of only being interested in methodologies that yield their favored conclusions.

In contrast to the the PKs, who offer nothing but "criticism," Noah points to “the Solow Growth model” as a useful and accessible scheme of analysis.  I’ll get to alternatives in a moment, but I think Noah is much too blasé about the importance of “criticism,” and his reference to “the Solow Growth model” provides a good illustration of the problem.

Leaving aside the Cambridge (UK) critique of aggregate production functions (the mere mention of which brands one a hopeless ideologue), here’s a brief paper by Jesus Felipe and Franklin M. Fisher, who carefully explain the conceptual difficulties with aggregate production functions and then patiently respond to all the justifications offered by those who still use these models despite their drawbacks.  

Some defenders of mainstream economics brush off critics, claiming they just don't know the math.  Well, Kenneth Arrow and Robert Solow, who do know the math, haven't been impressed by the modeling inspired by Lucas and Sargent.  Perhaps Stephen Williamson is right to dismiss these critics because they “fail to understand the power of the work they did,” but this claim requires an argument that addresses the actual criticisms offered by Arrow and Solow, not to mention those of Frank Hahn, Franklin M. Fisher, and several other first-class economists.

Noah is mistaken when he says PKs simply favor the methods that will produce their favorite conclusions.  I think, in opposition to Noah's view, that PK approaches and methods arise from their criticisms of orthodoxy.  

For brevity’s sake, I’m going to mention one assumption widely held among PKs, which is that neither market participants nor economists “know the data-generating process.”  Awhile ago, Brad DeLong, commenting on a Lars P. Syll post, granted that there may be something worthwhile in this point of view, but asked, “what kind of economic arguments do we make” once this assumption is accepted?

Here’s a short list of the sort of practical ramifications of assuming that neither market participants nor economists know "the data-generating process."

1. First, let me note that our ignorance is manifest in the disagreement among economists about the causes of the Financial Crisis and the Great Recession, the effects of QE on interest rates and inflation, etc.  Such disagreement gives rise to many, often inconsistent, beliefs about the economy, and this diversity of beliefs must be taken into account in thinking about the economy.  Isn't it worth modeling economies in which market participants hold conflicting views of the future?  Wouldn't such an economy behave differently from one in which everyone shares the same rational expectations?  Mordecai Kurz has done interesting work in the area. And agent-based modeling (Santa Fe style) may prove useful in thinking about interactions among agents with different “views of the world.”

2. If you don’t know how “the data-generating process” works, or if there is no such thing, then history, path dependence, and hysteresis should play a larger role in thinking about the economy.

3. Since agents don't possess a complete list of states and their probabilities of occurrence, many people rely on verbal models, narratives, and stories to guide their economic decision making, and the role these informal “models” deserve examination.  See some of Robert Shiller’s recent work as well as this paper, which finds the EMH wanting once "the news" is taken into account.

4. Disequilibrium micro foundations (and mutually inconsistent expectations) attracted a lot of first-class economists from the mid-1950s until the early 2000s, including Hicks, Debreu, Hahn, Samuelson, Clower, Leijonhufvud, Negishi, and several others.  Arrow, himself, thought of the macroeconomy as "a disequilibrium phenomenon," and this vantage point is worth another look.  R. Backhouse and M. Boianovsky wrote a good book on the subject.

It may be objected that the economists mentioned above are not Post Keynesians, or at least do not identify themselves as such.  I concede this point because I’m concerned with methods and approaches that avoid some of shortcomings of mainstream thinking, rather than with the purity of Post-Keynesian economies.